Chapter 3.4 - Price Stability (Inflation and Price Stability (Inflation -…
Chapter 3.4 - Price Stability
Cost of living and the General Price Level
The price level
- the average of current prices across all the goods and services.
Cost of living
- spending on goods and services bought by the average family.
Prices rise -> cost of living increases -> people's money will not buy as much as before -> quality of life falls
Inflation and Price Stability
- A sustained rise in the general price level over time, when on average prices of goods and services in the whole economy are rising
However, prices of some individual products may still fall
i.e. some technology becomes cheaper when overall prices are rising
- The general level of price is kept OR grows at an acceptably low rate over time.
The government wants to achieve an objective for the rate of inflation between 0% and 2%.
Rate of inflation
- The percentage rise in the general price level over time
Inflation can be negative when the price level is falling - money becomes more valuable
How is inflation measured?
All prices are recorded, put together and given the number 100 at the start of the period.
If prices rise for example by 2% then this is reflected in the index:
100+2 = 102 or 100*1.02 = 102
This is called the consumer price index (CPI) - an index that measures changes in the general price level of a typical consumer good or service
Real VS Nominal Values
A real value of worker's income
refers to goods and services that can be bought with that wage
If inflation is higher than the nominal increase in income, real value of income will fall - people are not able to buy as many goods or services
If income rises at a faster rate than inflation then the real value of income rises. People are able to buy more goods and services.
A nominal value
is a face value of something expressed in money terms
Causes of inflation
When rises in the costs of production cause firms to increase prices, raising the overall price in the economy
Costs of production include:
Fuel - oil, coal
Rent and business taxes
Raw materials -steel
Interest on loans
Wages and salaries
If costs rise firms will raise prices to maintain their profits
When aggregate(total) demand in the economy rises and the supply of goods and services does not increase to match it.
Usually happens in times of a boom in the economy --> high levels of employment --> high per capita incomes --> there is more money supply --> total consumer demand rises --> firms raise prices
Consumers in foreign countries
Firms demanding capital goods for investment
Demand comes from government spending
Consequences of inflation
Purchasing power of money falls
- Inflation makes the purchasing power of money fall over time. Savings will lose calue in real times of inflation.
The greater the rate of inflation the more savings will lose their value. Savers lose in times of inflatiion